No place for 1.75% trailer fees?

No place for 1.75% trailer fees?

Right there in the Cummings Report’s analysis of how past performance affects fund flows was the startling revelation that some fund companies still pay trailer fees in excess of 1%.

In fact, some go as high as 1.75%, prompting some within the industry to wonder why regulators don’t cap trailers – if not ban them outright. Others, however, see this as more money out of the pockets of advisors already shouldering a heavy regulatory burden.

“A 1.5% trailer is the epitome of what is wrong with financial advice in Canada” wrote Ottawa-based PWL Capital Investment Advisor Ben Felix in an email to WP. “If a fund pays a higher trailing commission than its peers, it becomes a conflict for commission-based advisors, which the Cummings Report implies using fund flow data. No advisor can predict which actively managed funds will do well in the future, and they are only held to a suitability standard, so why not recommend the suitable fund paying the highest trailer?"

So, who pays more than 1%?

According to a recent stat from a large Canadian fund company, only 10% of the 2,700 or so mutual funds in this country do so. But those that do really go to town.

For example, SEI Investments pays 1.75% for their Series D funds. In the case of its Canadian Equity Fund the MER works out to 2.88%, considerably higher than the 2.1% average for Canadian equity funds. By comparison, Fidelity’s True North Series B fund pays a 1% trailer with an MER of 2.29%.

Over the past five years the Fidelity fund delivered annualized returns of 8.12% according to Morningstar compared to 2.6% for the SEI fund. Score one for the Cummings Report.

Who else pays more than 1%? The banks do.

CIBC’s Canadian Equity Fund, Series A, pays a 1.25% trailer with an MER of 2.39%. Its annualized performance over the last five years was 3.95%, better than the SEI fund (1.75% trailer) but 417 basis points less than Fidelity’s True North.

Both of these examples highlight why some believe trailer fees should be capped – if not by regulators then perhaps by the industry itself.

“When it comes to fees, nobody is talking about value – what it is and how it’s delivered,” says Ottawa advisor Bob Roby. “One cannot legislate pricing. Rates, however, can be capped and guidance provided by the firms in question.

The President of Invesco Canada, Peter Intraligi, addressed this very topic with a letter addressing the Cummings Report titled: Invesco Responds To CSA on Mutual Fund Fees.

I took the time to address Mr. Intraligi's response and will enclose it here. Hello Mr. Intraligi:

Your response to the CSA report is reasonable, but it logically infers further points for regulatory consideration. Apparently Invesco has lobbied for a regulatory cap on trailing commissions at 1%. Have you also lobbied for a regulatory cap on fee for service at 1%? My understanding is that there is a far greater proportion of assets beingcharged more than 1% on a fee for service basis than on an embedded trailing commission basis. I have been informed by various third parties, that some dealers do not allow less than 1.25% on a fee for service basis. Fee for service, seems to be one important action that the investment industry has taken, as an early response to dealing with the implications of CRM II.

Your response, and the CSA itself, only seems concerned with sales/distribution costs of the mutual fund industry. Could you also publically endorse a regulatory cap on management fees charged by fund companies at 1%?

Obviously, much time, money, and effort is being put into CRM II to address regulatory concerns about investment fees and their transparency, this is my small effort in hoping to improve that result, while meeting with the spirit of your own response.

I think the biggest part these reports are missing is that they don't actually compare embedded trailing commissions to what clients are paying under 'fee based' models using F-class funds or securities. I myself have came across many clients - usually working with Bank-owned brokerages - that are paying in excess of 1% in compensation. I have seen these get as high as 2% + the f-class fees, etc. This seems excessive, although I am all for the client having the final say provided they are aware what they are paying.